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Gold Update: Another Opportunity

 November 01, 2012 02:11 PM

(By R. Scott Raynovich) Gold has just undergone another one of its swift and painful correction. After bottoming in July in the $1550-$1600 range, gold vaulted $200 in just two months, nearly kissing the magic $1,800. A reaction has followed, with gold being knocked down back toward $1,700.

This type of action is typically with. It is a volatile and enigmatic market. However, keep in mind it is also the strongest secular bull market extant, with gold being the best-performing asset class over the last decade, averaging 12% per year.

I think it will continue. And I think you need to buy this correction.

The first question you might ask is won't the gold bull market end? Not soon. My work shows there are major trends that support the gold bull market. Here are the biggest ones:

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* Money Supply Growth. Following the financial crisis of 2008, the U.S. Federal Reserve has followed a policy of "reflating" the economy by pushing down interest rates and increasing money supply. The price of gold has a historically high correlation with growth in the money supply. This policy is not likely to end any time soon. In fact, the continuing crisis in Europe and the advent of Quantitative Easing III (QEIII) by the Fed is likely to accelerate the trend.

* Negative Real Interest Rates. Gold does well in an environment of negative real rates. You calculate the real interest rates by subtracting the yield on the 10-year treasury from the inflation rate. Treasuries are yielding about 1.75%, inflation is running at an official rate of 2% but an actual rate of 3% or higher if you use other measures.

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I think these two trends are part of the current "Fed regime," that is the policies of the current Fed. Ben Bernanke's pledged to keep at them until 2015. His term is up in 2014. Recently pledges by Mitt Romney to not keep Ben Bernanke in 2014 have contributed to the recent weakness in gold. The market fears that if Romney is elected, you will get a more hawkish approach to interest rates.

This is crazy. The world economy is far to weak for politicians to risk reduceing interest rates now. The global banking system is still enormously fragile. They are terrified of this. They will continue to print mone.

So where does that leave us with gold? Below is a three-year chart of gold futures. Gold recently sold off hard down to a Relative Strength Index (RSI) reading of near 25. When the RSI gets into the 20s, this has typically been a goold time to buy gold.

You can also see that gold has been in a large one-year consolidation pattern after its aggressive run from $1,500 to $1,900 in 2011. There is recent support near the 200-day moving average at $1,660. This consolidation has formed a "wedge" pattern which will likely be resolved by the end of the year. My expectation is that it will be resolved to the upside -- possibly in an explosive way.



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